In coronavirus economy, don’t rush to refinance student loans

In coronavirus economy, don’t rush to refinance student loans

by Brianna McGurran
August 13, 2020

In coronavirus economy, don’t rush to refinance student loans

In coronavirus economy, don’t rush to refinance student loans

by Brianna McGurran
August 13, 2020

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The Federal Reserve cut interest rates to near-zero in March, making it less expensive for consumers to borrow money as a way to limit the coronavirus impact on the economy. That means you’ll likely see your credit card APR get cheaper, and so will interest rates on mortgages, auto loans and student loans.

If you’re currently paying down student loans, several private lenders offer the option to refinance them to a lower interest rate if you qualify. That might sound enticing right now since rates will dip across the board. But depending on your credit, income and job situation, refinancing — particularly if you have federal loans — could be a risky move.   

Here’s how to know if it’s right for you.

What is student loan refinancing?

When you refinance a student loan, a lender evaluates your finances and, if you meet its requirements, replaces your previous student loan with a new one at a potentially lower interest rate. That can save you money over time, especially if you also opt for a shorter repayment timeline and can pay off your loan faster, with less interest accumulating.

Not everyone will qualify for student loan refinancing. Lenders typically require a credit score in the good or excellent range, which is 670 or higher on the FICO credit scoring model’s 850-point scale. They’ll also want to see strong income and a low debt-to-income ratio to ensure you can make your payments.

Federal loan benefits you’ll lose when you refinance

While refinancing can mean big savings — especially on high-interest private loans you took out during a period when rates weren’t so low — there are some significant downsides. 

The biggest is that refinancing federal student loans will disqualify you from hugely beneficial federal repayment programs, which you might need now more than ever. Only private lenders offer student loan refinancing, which means any federal loans will turn private when you refinance them. 

That means you’ll lose access to:

  • Generous payment postponement options, including the ability to put loans into deferment or forbearance for up to three years in some cases. Plus, if you have subsidized federal loans, the government will pay the interest that accrues during periods of deferment. That means the amount you owe won’t have grown by the time you start making payments again.
  • Income-driven repayment plans, which are crucial in case you have concerns about student loan affordability long-term. They lower monthly student loan payments to 10% to 20% of your discretionary income, depending on the plan, and offer forgiveness on the remaining balance after 20 to 25 years of payments. You must meet income requirements to participate in some plans, but one — called Revised Pay As You Earn — is open to all federal loan borrowers. 
  • Student loan forgiveness, which could be tax-free if you qualify for the federal Public Service Loan Forgiveness program. Depending on your job and the type of loans you have, you might be able to get your federal loans forgiven after a period of time. Public Service Loan Forgiveness, for instance, offers tax-free forgiveness after 120 monthly payments if you meet the requirements. Teachers and Perkins loan borrowers also have access to specific forgiveness programs. 
  • A relatively long period before student loan default.  If you don’t pay your federal loans for 90 days, they’ll be reported delinquent to the credit bureaus and you’ll see late payments posted to your credit report. Your loans will go into default status after you’ve missed payments for 270 days, a longer time period than private student lenders typically provide. Default leads to serious consequences, like ruined credit and loss of access to federal student aid. But with federal loans, you’ll have nine months to address affordability concerns and prevent default from happening. That’s important because the default will appear on your credit report for seven years, affecting your ability to borrow money and qualify for lower interest rates on loans and credit cards in the future. 
  • Potential federal student loan relief related to the coronavirus’s economic impact. The U.S. Department of Education has already said that it will start waiving interest on federal student loans currently in repayment. That means monthly payments won’t change, but all the money you pay will go toward your principal balance, which could help you pay off loans sooner. If you refinance federal loans, you’ll lose out on the potential benefits of federal aid to borrowers, more of which may be on the horizon.

What to consider before you refinance student loans

While it’s natural to explore ways to save money in the environment we’re in now, don’t rush into refinancing just to lock in a lower interest rate. Ask these questions first:

What type of student loans do you have?

First, identify if you have federal loans, private loans or a mix. You can figure that out by logging into your Federal Student Aid account. (You’ll need an FSA ID; create one if you don’t have it yet.) Once you’re logged in, you’ll be able to view your outstanding federal student loans and other important information, including the company that collects your payments on behalf of the government.

You can find your private student loans by checking your credit report; it will list all your current credit accounts, including student loans, plus their balances and originating lenders. Any student loans on your credit report that aren’t listed in your Federal Student Aid account are private loans.

How secure is your income?

While the coronavirus’ economic impact won’t last indefinitely, it could affect your income in the short term, making it more likely that you’ll need federal student loan protections. Before refinancing, consider your individual financial situation in the next three months to a year:

  • Do you or a partner work in an industry that could limit your hours or institute layoffs? 
  • Would a potential illness or period of quarantine affect your ability to earn money?
  • Are you working toward, or thinking about working toward, federal student loan forgiveness, which refinancing would disqualify you from?

If you’re concerned about job security or your ability to afford other bills and loan payments, avoid refinancing federal loans. You may need to take advantage of income-driven repayment, deferment or forbearance, and losing those options could mean falling behind. Right now, limiting the potential fallout from lost wages is more important than taking advantage of a rate cut.  

Could you get better terms on a new loan?

While federal loans may not be safe to refinance right now, private loans are a different story. You could stand to save money with a lower interest rate, without the risk of losing federal loan protections, and your new lender might also provide better terms than what you previously received. 

For instance, some private lenders charge borrowers to sign up for forbearance, says Persis Yu, director of the National Consumer Law Center’s Student Loan Borrower Assistance Project. If your current lender does so, you could refinance to a new lender that charges fewer fees, or that offers more flexible forbearance options.

Or, you could independently refinance a private loan that currently includes a co-signer. That would make you the only borrower on the new, refinanced loan, releasing your co-signer from the responsibility of potentially covering payments if you can’t. Parents who co-signed your student loans and who are in or near retirement — with their own concerns about affording bills — could benefit, for example.

No matter the case, make sure you’re sure you’ll be able to make payments as planned to a new lender before refinancing. You’ll save the most money on interest if you can refinance to as short a loan term as you can manage; five years, for instance, is a common term refinance lenders offer. But right now isn’t the time to take risks with your money. There’s no rush to refinance, this week or in the future — focusing on your health, protecting your emergency fund and ensuring you can cover necessities like housing and food could be the better call for now.

This article was written by Brianna McGurran from Forbes and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.

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